Friday, 26 April 2013

Housing problems - lessons from Ireland (3)

What caused the Irish housing boom and bust crisis, and could it happen here?

The biggest element in the Irish event was a grossly inappropriate monetary policy. After Ireland joined the Eurozone, it got the monetary policy of the European Central Bank - it got low interest rates, reflecting the slow growth conditions in the major Eurozone economies. Ireland, on the other hand, was 'the Celtic tiger', with strong growth in output, incomes, and prices. The 'one size fits all' Eurozone interest rates were way, way too low for an economy growing at a gangbusters rate.

The other important element was the 'me too' behaviour of both borrowers and lenders. On the borrowers' side, people saw their neighbours making pots of money by taking out mortgages at the low Eurozone interest rates, and buying houses that trebled in value in a decade. The house buying took on a self-fulfilling frenzy. On the lending side, banks, even if they saw a problem lurking down the track, and they may not have, did not want to lose out to their competitors when it came to getting their fair share of this booming mortgage market, so they accommodated the boom as well.

It didn't help that neither borrowers nor lenders were able to sort out, in real time, the speculative excesses from the increases that would have happened perfectly naturally anyway. There was strong net inward migration to Ireland (70,000 people a year at its peak), and strong growth in employment and incomes. House prices would have risen by some amount - perhaps by a substantial amount - in any event. Who, in the midst of very robust economic conditions, is able to figure out that the first 10% of price appreciation is in line with the strong economic fundamentals, but that the next 5% or 10% or 20% isn't?

Could it happen here? To some extent, we've got the Irish problem of importing too-easy monetary policy: we've had to match, or at least get within spitting distance of, the zero or near zero short term interest rates of the major OECD economies, to prevent our currency being driven up to even more insane levels. We've certainly got the same household and bank behaviour. And we've got some modest level of genuinely higher demand for housing, from immigration and from net increase of the domestic population, coupled with some degree of constraint on supply responding quickly to the increased demand. Increased demand and constrained supply make for higher prices, and can seed a subsequent expectations-driven bubble.

You can see why the Reserve Bank is worried. And you can also see why it won't be a surprise if the Bank tries to stop the arms dealers supplying the ammunition for this campaign - or in other words, looking to do something about the banks providing easy finance for a housing debacle.

No comments:

Post a Comment

Welcome to my economics blog

“The remarkable thing about economics is that once you've been exposed to the big ideas, they begin to show up everywhere … Economics offers insight into wealth, poverty, gender relations, the environment, discrimination, politics...How could that possibly not be interesting?” - Charles Wheelan, Naked Economics: Undressing the Dismal Science, 2002

"The soundest argument for markets ... is simply that, very frequently, they are the least bad of the alternatives. To paraphrase Winston Churchill's remark on democracy, markets are the worst form of resource allocation, except for all the others that have been tried" - Prof George Yarrow, Three Lectures on Privatization, Jagiellonian University, Krakow, April 1990

"And if there's one thing we've learned about flawed markets, it's that people flee from them, either physically or by resorting to back channels and black markets. Either way, flawed markets can undermine not just communities but whole nations" - Alvin Roth, Who Gets What - and Why, 2015

"Economic controversy is generally a thankless task. You cannot hope to make any impression on your opponent. Yet he is the only reader on whose interest you can count" - Francis Ysidro Edgeworth, Economic Journal, 1898

"There is some evil genius which sits at the elbow of every economist, forcing him into all sorts of contorted and unnecessary complications" - John Maynard Keynes, letter to Roy Harrod, August 1935

"We are here and it is now. The way I see it is, after that, everything tends towards guesswork" - the philosopher Didactylos, in Terry Pratchett's Small Gods, 1992

"I have never yet seen any plan which has not been mended by the observations of those who were much inferior in understanding to the person who took the lead in the business" - the blogger's creed, as foreshadowed by Edmund Burke, Reflections on the Revolution in France, 1790

"They acted as their situation naturally directed, and they who have clamoured the loudest against them would probably not have acted better themselves" - advice to Twitterati, as foreshadowed by Adam Smith, An Inquiry Into The Nature and Causes of the Wealth of Nations, Book IV, 1776